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entrepreneur guide to crowdfunding

Crowdfunding

What is Crowd Funding?

Crowdfunding is the option where the fund is raised from a large number of people in small amounts especially using the internet.  A project report is prepared and it is demonstrated on the internet and a request is raised to the communities to support for the funding.  In India, Crowd Funding rules are different from other countries and it is strictly governed. In all sense, it is legal but with a different rule.  

Typically there are three different types of crowdfunding options:

Equity-based:  Equity crowdfunding is a mechanism where a group or section of investors subscribes in small quantities, equity shares for start-up or small business. Generally, a bootstrapped start-up needs small funding which is supported by a consortium of angel investors with small support.  In equity crowdfunding, individually these investors purchase shares in the company. Equity crowdfunding doesn’t fulfill the basic condition of Registrar of Companies like:

  • For a private limited company any private placement cannot  ;
  • More than 200 members cannot invest at a time in the company in a year;
  • Valuation of shares of the company is must when the investment is happening;
  • Equity shares have to be issued to each member who has invested the money;
  • Shares of a private limited company are not governed by SEBI and are not freely tradable.

Debt-based (Peer to Peer): Debit based crowdfunding allows a group of lenders to lend funds to start-ups or small business on interest payment where the money is returned after the completion of the period for which is lend.   Also known as Peer to peer lending. Lending is mostly done on the company demonstrating their creditworthiness to pay interest and capital on close of the contract. India rules are regulated by registering any organization into a Non-Banking Financial company typically known as NBFC to enter into P2P lending space and it is governed by a certificate issued by RBI.  Some of the basic restriction to follow are:

Basic Rules of P2P Lending:

  • Minimum capital investment of 2 Cr is must at the time of registration or subsequent raise to apply for NBFC legal format;
  • The platform cannot raise deposit;
  • The platform cannot lend their own money to borrowers;
  • The platform can work only as aggregator who is bringing lender and borrowers together for lending on interest decided mutually between the lender and borrower;
  • Cannot receive or allow the international flow of funds through this medium;
  • A lending cycle in India under a P2P should not be more than 36 months in the current rules;
  • The total amount is capped up to Rs 10 lakhs for one potential lender and borrower with all P2P NBFC’s;
  • The exposure for a single lender to the same borrower through all P2P should not exceed more than 50,000;
  • The dealing of borrowing and lending should be directly between the two parties and platform is only the facilitator;
  • The platform cannot guarantee any fixed income, the return of money or any sort of commitment to attract money for lending;
  • Cross-selling of other products are not allowed through platform except for insurance related to lending;
  • All transactions are through movement in escrow accounts;

P2P Lending NBFC expected to:

  • Define the do’s and don’ts clearly for all the lending transactions;
  • Undertake due diligence of people participating in the transactions;
  • Undertake creditworthiness and risk checking of borrowers and share with lenders;
  • Ensure are documentations are complete and shared with respective people before the transfer or money;
  • Offer process for recovery of loan and legal assistance for non-payments.

Donor-based: Crowdfunding under this route is done mostly to support businesses for social causes.  The donation-based crowdfunding model is where NGOs or individuals appeal for donation and fund their idea for social causes. Donation-based crowdfunding works great for social good or medical patients looking to fund a life-saving treatment that they can’t afford. Mostly it is used effectively by non-profit organizations.

Reward-based: It is similar to Donor Based crowdfunding but different as the receiver gives a reward from his product or services in lieu of money given as donation by the donor.  Like if a Chartered Accountant is looking for Reward based funding can offer to give his CA services free of cost to people and business how have donated money.

How Crowd Funding is done?

  • Select a crowdfunding platform where a project has to be listed;
  • Platform do due diligence of the project;
  • Platform do documentation required for crown funding;
  • A person wants to raise crowdfunding register with the platform;
  • Advertise your project or start-up idea through the   platform;
  • Create the hype of the project through campaigning on the platform;
  • Pay commission and subscription fees to the platform and raise money.

Here are the Crowdfunding Rules in India:

  • A retail investor can contribute maximum up to Rs.60,000/-.
  • Only early stage start-up and who are less than 2 years old are only allowed to participate in crowdfunding activities;
  • Start-ups intend to get funded must disclose their business idea, plans, current, and past financial statements and future plans to show the need for funds on the platform.
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